The States and the Pains to Come

The National Governors Association convened its 102nd annual meeting in Boston over the weekend. This year’s formal agenda focused on issues relating to health care reform, streamlining state government and the challenges presented by rapid growth in the federal debt burden. Behind the scenes and off the record, the nation’s governors are undoubtedly also focused on addressing persistent gaps in state and local budgets and on engaging the federal government for additional stimulus funds.

Speaking to the governors on Sunday, the co-chairman of the National Commission on Fiscal Responsibility and Reform, Erskine Bowles and Alan Simpson-formerly chief of staff under President Clinton and Republican senator from Wyoming, respectively-described the current direction of public finance as “a cancer … that will destroy the country from within.” While their comments may have been in reference to the precarious state of federal finances, the states’ predicaments are already at the fore.

Here in New York State, a multibillion-dollar gap between projected revenues and expenditures has resulted in a drawn-out and piecemeal adoption of the fiscal year 2011 budget. A revenue bill is still outstanding, but the timeline for its passage is undetermined. As my colleague Bob Knakal described in his mid-June Concrete Thoughts column on Albany’s budget process, “[W]ithout a state budget in place, municipalities are unable to set their own budgets with confidence, as the level of the state’s contribution is uncertain.”

Clarity on the state budget is necessary for an effective local budgeting process. Similarly, how effectively the state addresses the budget gap-and whether the remedies help or hinder business and household growth-is critically important for the health of the New York City economy and our commercial real estate sector.

The States of the States

According to the Fiscal Survey of States, 46 of 50 states are on track to report fiscal year 2010 revenues below their originally proposed budgets. Only two states, Florida and Virginia, have bucked the broader trend. In Florida, corporate tax collections have exceeded original projections by almost 15 percent. In both states, additional spending cuts were still required after the adoption of the 2010 budget.

In spite of the nascent economic recovery, many states face more difficult budgetary choices in the next fiscal year than in the last. Thus far, federal transfers of $135 billion authorized under the American Recovery and Reinvestment Act have offset shortfalls in state tax revenues. Roughly two-thirds of the federal support was for Medicaid; the balance, for education. Even then, 37 states, including New York, cut education spending to the tune of $7.8 billion in 2010. New York was also among the 30 states cutting Medicaid spending by $1.5 billion.

The benefits of the Recovery Act support will taper off in 2011, exposing states to the full extent of their budget gaps. Persistent unemployment will undermine growth in sales and personal income taxes. Together, these two inflows account for almost 75 percent of general fund revenue. Corporate tax revenues will exceed projections in some states, but are a relatively small 8 percent of total state revenues.

In all, combined state revenues from sales taxes and personal and corporate income taxes in 2011 are projected to fall 8.4 percent below their 2008 peak levels. To close the gap, and apart from idiosyncratic cuts in each state, 34 states will cut education spending in 2011; 20, public assistance; 26, Medicaid spending. As of the governors’ most recent update, planned cuts still leave $62.3 billion in deficits unresolved.

Why Does It Matter?

In a recent briefing note, Mark Muro, policy director at the Brookings Institution’s Metropolitan Policy Program, points out that “federal, state, and local government can make up 17 or 18 percent of a state’s or metro’s employment. Local government alone accounts for one in 10 nonfarm jobs in large metros.”

In New York City, government payrolls account for 15 percent of all jobs, exceeding financial services in number of jobs, though not in dollar value of payrolls. Expanding the scope of jobs dependent on some level of state and local funding to include education and health services, the relevant share expands to 36 percent of the city’s jobs. In the most basic analysis, the rebalancing of state and local budgets will mean workforce cuts that sap local demand for a wide array of goods and services.

Painful job cuts aside, budgetary rebalancing is even more important because of its implications for the long-term health of the local economy. Closing the budget gap inevitably means some combination of higher taxes and diminished services. The states and cities that find the most efficient balance of taxes and services will, in the long run, outperform their less efficient nearby peers. Charles Tiebout (famous among urban economists for his 1956 paper “A Pure Theory of Local Expenditures”) outlined the basic conceptual framework still used in thinking about tax and service efficiency in local competition for jobs and residents.

New York’s choices must be evaluated against measures taken elsewhere. In this regard, Albany has proven a weak steward of the state’s and city’s futures.

If New York City is to prosper in the long run, our elected officials must find dramatically more effective ways of working together when confronted with difficult choices.

schandan@rcanalytics.com

Sam Chandan, Ph.D., is global chief economist and executive vice president of Real Capital Analytics and an adjunct professor of real estate at Wharton.